This blog is part of an ongoing series exploring the intersection between intermediary cities in developing countries and sustainable development

Intermediary cities are the fastest growing cities in the developing world. Often referred to as secondary or second-tier cities, intermediary cities typically have a population of between 50,000 and one million people. They play a fundamental role in connecting both rural and urban areas to basic facilities and services.[1] Driven by population growth and rural-urban migration, intermediary cities worldwide are projected to grow at almost twice the rate of megacities (those with more than 10 million inhabitants) between now and 2030.[2] Of these, the fastest growing cities are in Africa and Asia.[3]

With such rapid population growth, and despite corresponding economic growth, intermediary cities are frequently unable to meet the demands placed on their infrastructure. They fail to make necessary investments to maintain existing assets and develop new assets for housing and basic urban services such as water and sanitation. The implications for health, livelihoods and overall quality of life for residents are serious. Inadequate water and sanitation systems or flood defense infrastructure, for example, increase vulnerability to disease, natural disasters and economic losses.[4]

The bottom line is that the investments needed for infrastructure in intermediary cities are growing rapidly and far exceed available capital. Local governments in intermediary cities turn to their own sources of revenue from taxes or fees, tariffs, transfers from central governments, or less often, debt capital to invest in infrastructure. Yet, these often fall short, even in primary cities. Legal frameworks for fiscal decentralisation are not in place in many developing countries, and national governments often do not prioritise infrastructure investment in intermediary cities.[5] While financial markets have the potential to contribute substantially to closing the “infrastructure investment gap,” intermediary cities[6] in Africa and Asia are often unable to borrow due to poor creditworthiness, policy constraints or restrictions placed on them by national governments.

For example, 2017 data show that in18 intermediary cities in South Africa, external loans funded a mere 21% of total spending on new capital assets. Only half of these cities borrowed externally to finance these assets, with a single city borrowing 48% of the total.[7] South Africa’s experience shows that using external loan financing to fund significant capital acquisition – a rarity in sub-Saharan Africa – is still the exception rather than the norm.

A shift in mentality is needed if fast-growing intermediary cities are to raise significant debt capital to finance investments in infrastructure. Local governments need to work to improve their capital planning and financial management capacities, while policy reforms are required to give cities the power to issue bonds and access public and private sector capital through lending markets.[8] Credit enhancements and policy incentives will be required to attract sources of capital unfamiliar with these borrowers. And the donor community can play a key role in maximising the funds available for infrastructure spending through leveraging.

Aid agencies have long supported local governments in developing countries design comprehensive systems for land registration and titling, increasing their capacity to collect land and property taxes.[9] Democracy and governance programmes also often work in this space to improve local governments’ operating environments for basic service delivery. Still, these types of interventions alone are insufficient to close the infrastructure investment gap faced by intermediary cities in the short and medium term. Rather, complementing these efforts by supporting intermediary cities in improving creditworthiness and accessing commercial loans is key. For instance, the United States Agency for International Development (USAID) is working with South Africa’s 39 intermediary cities to develop long-term capital infrastructure investment plans and identify appropriate financial instruments, sources and tools to ensure that the useful life of assets better aligns with potential funding structures and sources of capital.

Development finance institutions (DFIs) are also helping intermediary cities move from dependence on transfers and grants to building a credit history through concessionary and blended borrowing. For example, KfW, Germany’s DFI, invested in a financial intermediary in the Indian state of Tamil Nadu. Established in 1996 with USAID and World Bank support, the Tamil Nadu Urban Development Fund (TNUDF) provides cities in Tamil Nadu with direct loans and grants for infrastructure projects. Since 2008, KfW has invested EUR 260 million in grants and term loans, including through the Water and Sanitation Pooled Fund (WSPF) that enables smaller cities in Tamil Nadu to access debt finance.[10]

In addition to supporting TNUDF and WSPF in India, the World Bank extended over USD 7 billion in sovereign loans since 2000 to finance projects in intermediary/secondary cities,[11] including:

a USD 120 million credit to Côte d’Ivoire for an Infrastructure for Urban Development and Competitiveness of Secondary Cities Project (2018-2022) that invests in road infrastructure and market facilities in Bouake and San Pedro and supports developing urban master plans;[12]

a USD 95 million credit to Rwanda for an Urban Development Project (started in 2017) that invests in basic infrastructure (roads, lighting, sidewalks) in six secondary cities;[13] and

a USD 90 million credit to Niger for an Urban Water and Sanitation Project (2011-2015, subsequently extended) that invests in water and sanitation infrastructure (pipes, tanks, boreholes, treatment facilities) in six secondary cities.[14]

Support like this from aid agencies and DFIs allows intermediary cities to gain exposure to debt repayment, demonstrate creditworthiness, enhance their credit profile and improve local service delivery. The ability of South African intermediary cities to borrow from debt capital markets today is largely dependent on financial, technical and managerial support they received from the national Municipal Infrastructure Investment Unit in the early 2000s, which a number of bilateral donors funded.[15] More recently in Bangladesh, the UN Capital Development Fund supported nine municipalities in attaining investment grade credit ratings, a critical first step towards raising commercial finance for infrastructure spending.[16]

Clearly, the donor community can build the individual and institutional capacity of municipalities and their decision makers through technical assistance programmes. But more is needed. What’s instrumental is building the creditworthiness of intermediary cities and expanding their access to finance for infrastructure. More and better coordination amongst donors and governments to leverage diverse programmes in land tenure, in democracy and governance, and in public and capital markets finance would go a long way to unlock local private finance, which, after all, is an indispensable ingredient for sustainable development.

* This blog was produced with funding from the United States Agency for International Development (USAID) by Tetra Tech through the Water, Sanitation and Hygiene Finance (WASH-FIN) programme Task Order under the Making Cities Work (MCW) Indefinite Quantity Contract. The views expressed here are those of the authors and do not necessarily represent or reflect the views of USAID.

[…] But economic growth would splinter in ways Airbus did not predict. Intermediary cities are growing almost twice as fast as megacities, according to a 2018 paper posted by the Organisation for Economic Co-Operation and Development. […]